LUCENT TECHNOLOGIES AT&T spun off its research and development division (the former Bell Laboratories) in April of 1996, and the newly independent company - renamed Lucent Technologies - was an instant hit with investors. The company's stock became the most widely held in the United States, and over the following 3 years and 9 months its price increased 892%.1 This remarkable price appreciation tracked a series of steadily increasing earnings that exceeded analyst expectations. Lucent, in fact, had beaten those expectations in each of its 15 quarters of operations (Zacks, 2000). Lucent Technologies manufactures, sells and services voice and data communications systems and software. By the end of its fiscal-year 1999, Lucent generated over thirty eight billion dollars in annual revenues, employed over 150,000 people, and had offices in more than ninety countries worldwide. On October 26, 1999, Lucent issued a press release describing record earnings for both the quarter and the fiscal year ended September 30, 1999 (Lucent, 1999a). Lucent's revenues were up 23 percent, and earnings were up 50 percent from the fourth quarter of the previous year. For the fiscal year, Lucent's revenues and earnings were up 20 and 46 percent respectively. Lucent's chairman and CEO, Richard McGinn, described the results saying: "Lucent enters the new millennium with momentum. This was the strongest quarter and the strongest year in Lucent's history." The report of these record results was accompanied by another press release. This second announcement outlined a realignment of Lucent into "four core businesses." This realignment was, in the words of McGinn, "...intended to mirror the way we are approaching customers today - with converged network solutions. We are sharpening our focus on high-growth areas - such as data networking, optical networking, wireless semiconductors, e-business and professional services - while speeding our growth in international markets. And, we will also be aligning our management structure to increase productivity and accelerate our response to customer needs" (Lucent, 1999b). Over the ensuing days and weeks, Lucent's share price soared. Climbing steadily from $59 7/8 on October 25, 1999, it traded at prices over $82 during December 1999, and closed at $72 3/8 on January 5, 2000. On January 6, however, Lucent filed a Form 8-K with the U.S. Securities and Exchange Commission. Form 8-Ks are used to report "material events," and Lucent's "event" was that first quarter earnings for the quarter ended December 31, 1999 would be significantly below expectations. Lucent reported that its revenue from Service Provider Networks was down 2%. A result, company executives said, that was caused by the domino effect of unanticipated customer shifts to new optical systems and the manufacturing deployment and capacity problems that ensued. Indeed, analysts estimated that Lucent lost up to $1 billion in sales because of production delays, delivery problems and cancelled orders during the quarter (Dow Jones, 1/20/00). 1 Lucent's beta as reported by Yahoo Finance was 1.6 on January 6, 2000 (see attached) Although Richard McGinn, said the company expected its problems to be resolved by the end of the second quarter, and Lucent's Chief Financial Officer, Don Peterson described the shortfall as a "bump in the road," (Burns, 1/27/00) the response of investors was harsh. The company's stock price fell from $72 3/8 to $52. Erasing in that single day, more than $80 billion in market capitalization and a year's worth of gains. Furthermore, a number of class action lawsuits were filed on behalf of investors who had purchased Lucent's stock between October 27, 1999 and January 6, 2000 (PRNewswire, 1/20/00). The suits claimed that Lucent violated Sections 10(b) and 20(a) of the Securities Act of 1934 by issuing a series of materially false and misleading statements that failed to disclose the weaker-than-expected performance in a timely fashion.

REQUIRED 1. Conduct a DuPont decomposition of Lucent's ROE by quarter. What factors contributed to the differences in Lucent's performance between those quarters? 2. Evaluate the seasonally adjusted change (i.e., quarter i in year t to quarter i in year t-1) in Lucent's: Sales, Accounts Receivable, Inventory and Gross Margin for the five quarterly periods: December 1998 through December 1999. Be sure to include an evaluation of the Footnote disclosures regarding Lucent's inventories in your examination. Does the explanation for the earnings shortfall provided by Lucent's managers make sense in light of your analysis? 3. Based on your analysis: a) When might you have determined that Lucent would be unable to maintain its streak of record earnings? b) Do you think the class-action lawsuits have merit? c) Would you expect Lucent's earnings to 'recover' by the second quarter of 2000? What obstacles to Lucent's earnings recovery present themselves?

EXHIBIT 1 LUCENT TECHNOLOGIES Rotate Page Clockwise By 90 Degrees Earnings Per Share Data For the Quarters Ended: Dec-99 Sep-99 Jun-99 Mar-99 Dec-98 Earnings Per Share 0.36 0.31 0.26 0.17 0.52 Analyst Expected Earnings Per Share 0.43 0.29 0.23 0.15 0.50 Difference (0.07) 0.02 0.03 0.02 0.02 % Surprise -16.28% 6.90% 13.04% 13.33% 5.00% EXHIBIT 3 LUCENT TECHNOLOGIES Consolidated Balance Sheets For the Quarters Ended: Jun-99 - Mar-99 Dec-98 Dec-99 Sep-99 Sep-98 Jun-98 Mar-98 Dec-97 Sep-97 Assets Cash Receivables Less Allowance Inventory $ 2,219 S 10,143 381 5,380 1,164 1,504 1,168 $ 21,578 S 6,986 7,693 6,078 1,816 $ 10,438 362 5,048 1,103 1,583 1,943 21,931 $ 6,847 7,445 6,485 1,495 $ 9,486 393 5,179 1,338 1,784 1,528 20,810 $ 6,257 7,274 6337 792 $ 8,752 349 4,332 1,106 1,632 1,160 17,774 $ 5,751 6,935 6,210 940 $ 9,185 346 3,778 1,060 1,620 768 17,351 $ 5,645 6,886 6,068 685 $ 6,939 390 3,081 1,259 1,623 491 14,078 $ 5,403 6,382 3,754 750 298 2,437 26,720 $ 1,099 $ 969 $ 5,792 5,576 374 369 2,973 2,874 1,405 1,332 1,554 1,477 482 481 13,305 $ 12,709 $ 4,957 4,805 6,253 6,132 3,597 3,462 832 1,002 289 279 2,299 2,407 25,279 $ 24,664 $ 1,225 S 6,295 344 2,604 1,214 1,469 449 13,256 S 4,729 6,121 3,322 1,120 246 2,079 24,752 S 1,350 5,373 352 2,926 1,046 1,333 473 12,501 5,147 6,407 3,172 1.262 293 1,436 23,811 506 3,486 $ 38,634 5 470 3,002 38,735 $ 412 3,340 37,156 $ 346 2,759 32,840 $ 306 2,271 31,641 $ Contracts in Process, net Deferred Taxes, net Other Current Assets Total Current Assets Property & Equipment (net) Accumulated Depreciation Pre-paid Pension Costs Deferred Taxes, net Capitalized Software Development Costs Other Assets Total Assets Liabilities and Shareholders' Equity Accounts Payable Payroll and Benefit Liabilities Post-retirement and Post-employment Benefit Liabilities Debt Maturing within One Year Other Current Liabilities Total Current Liabilities Post-retirement and Post-employment Benefit Liabilities Long Term Debt Other Liabilities Total Liabilities Common Stock Additional Paid-in Capital Guaranteed ESOP Obligations Retained Earnings Accumulated Other Comprehensive Income or Loss Total Shareholders Equity Total Liabilities and Shareholders' Equity $ 2,162 $ 1,321 103 2,672 3,659 9,917 S 6,013 3,832 2,793 $ 22,555 $ $ 32 $ 9,032 (30) 7,296 (251) $ 16,079 S $ 38,634 $ 2,878 $ 2,300 137 2,864 3,599 11,778 $ 6,615 3,812 2,908 25,113 $ 31 $ 7.763 (33) 6,105 (244) 13,622 $ 38,735 $ 2,705 $ 2,001 169 3,080 4,001 11,956 $ 6,533 3,712 2,552 24,753 $ 30 $ 7,339 (34) 5,240 (172) 12,403 $ 37,156 $ 2,410 $ 1,724 184 3,185 4,059 11,562 $ 6,471 3,716 2,040 23,789 $ 27 $ 4,996 (34) 4,384 2,468 $ 1,857 186 3,763 4,167 12,441 $ 6,413 2,404 1,946 23,204 $ 13 $ 4,706 (49) ) 3,565 (198) 8,437 $ 31,641 $ 2,040 $ 2,511 187 2,231 3,459 10,428 $ 6,380 2,409 1,969 21,186 $ 13 S 4,468 (49) 1,364 (262) 5,534 $ 26,720 $ 1,727 $ 1,659 $ 2,354 2,048 194 195 2,423 1,898 3,498 3,618 10,196 $ 9.418 $ 6,286 6,249 1,899 1,918 1,976 2,043 20,357 $ 19,628 $ 13 $ 13 $ 4,251 4,076 (63) (63) ( 1,028 1,314 (307) (304) 4,922 $ 5,036 $ 25,279 $ 24,664 $ 1,496 S 2,178 221 1,757 4,310 9,962 S 6,136 1,945 2,038 20.081 S 6 S 3,717 (77) 1,298 (273) 4.671 S 24,752 S 1,931 2,178 239 2,538 3,852 10.738 6,073 1,665 1,948 20,424 6 6 3,047 (77) 602 (191) 3,387 23,811 (322) 9,051 $ 32,840 $ EXHIBIT 4 $ 1.902 LUCENT TECHNOLOGIES Consolidated Statements of Income* For the Quarters Ended: Sep-99 Jun-99 Mar-99 Dec-98 Sep-98 10,575 $ 9,315 $ 8,220 $ 9,842 $ 8,574 $ 5,706 4,834 4,327 4,630 4,443 4,869 4,481 3,893 5,212 4,131 2.251 1,984 1,972 1,131 1,139 1,050 3,382 3,125 3,041 3,022 1,487 1,356 852 2,262 92 19 (65) 116 (43) 114 119 95 78 71 1,465 1,256 692 2,300 995 493 427 235 777 348 972 $ 829 $ 457 $ 1,523 $ 647 $ 1,937 1,013 Total Revenues Cost of Sales Gross Margin Selling, General and Administrative Expenses Research and Development Total Operating Expenses Operating Income Other Income (Expense), net Interest Expense Income Before Taxes Income Tax Expense Net Income 1,141 Dec-99 9,905 $ 5,259 4,646 1,908 978 2,886 1,760 66 98 1,728 553 1,175 $ 2,950 Jun-98 7,642 $ 4,087 3,555 1.673 1,002 2,675 880 (17) 63 800 282 518 $ Mar-98 Dec-97 Sep-97 6,184 $ 8,724 $ 6,933 3,436 4,519 3,873 2,748 4,205 3,060 1,501 1,555 1,608 932 829 835 2,433 2,384 2,443 315 1,821 617 31 14 51 58 79 72 288 1.756 596 102 632 227 186 $ 1.124 $ 369 1,109 $ * Excludes one-time events and the cumulative effect of accounting changes EXHIBIT 5 Notes to Consolidated Financial Statements Supplementary Balance Sheet Information Jun-99 Mar-99 Dec-98 Sep-98 Jun-98 Dec-99 Sep-99 Mar-98 Dec-97 Sep-97 Inventories Finished Goods Work in Process Total Inventories 3062.00 2318.00 5380.00 2946.00 2102.00 5048.00 2917.00 2262.00 5179.00 2281.00 2051.00 4332.00 1777.00 2001.00 3778.00 1578.00 1503.00 3081.00 1594.00 1379.00 2973.00 1463.00 1411.00 2874.00 1291.00 1313.00 2604.00 1611.00 1315.00 2926.00 EXHIBIT 6 LUCENT TECHNOLOGIES Common Stock Price (Adjusted for Splits) 90 80 70 09 $ Price per Share 50 40 30 20 10 1/1/00 7/1/99 10/1/99 1/1/99 4/1/99 7/1/98 10/1/98 1/1/98 4/1/98 7/1/97 10/1/97 1/1/97 4/1/97 4/1/96 7/1/96 10/1/96 0 April 1996 through January 2000